Low-cost competition cuts into Alaska Airlines’ profits

Alaska Air Group Inc. announced yet another quarter of profits July 25.

The airline reported an adjusted net income of $105 million for the second quarter of 2013, compared to $111 million for the second quarter of 2012.

That’s more than the company’s first quarter adjusted net income of $44 million, but ends the four-quarter streak of record-breaking profits.

In an investor call July 25, Alaska Airlines President and CEO Brad Tilden said that additional capacity in some markets, particularly Alaska but also other West Coast markets, contributed to the decrease in adjusted profits.

“Much of the unit revenue shortfall came in the state of Alaska, where over the years, we have seen airlines and flights come and go,” Tilden said in the call. “Given the importance of the state, we obviously plan to staunchly defend our turf there.”

Alaska Airlines has offered lower than usual prices on flights out of Anchorage and Fairbanks to Lower 48 destinations that are also served by competitors, such as discount airline Jet Blue.

Those market dynamics will likely impact the company less in the fall, when competitors retreat from the market during the slow season.

Andrew Harrison, Alaska Airlines vice president of planning and revenue management, said in response to a question that there are 7.5 extra flights this summer, but there will only be one by November.

Next summer, he later noted, the company will be better prepared to handle the dynamics.

“Honestly, with the state of Alaska already in June, I can personally see where we took the yield hits, where the passengers disappeared, which markets were from all over the country,” Harrison said.

“We will be very well-positioned if this occurs again next summer to do a much better job.”

Overall, the company had $1.25 billion in operating revenue for the second quarter this year, compared to $1.21 billion in the second quarter of 2012. That 3 percent increase included increases in revenues from several sectors, including passenger and freight. The number also is an increase compared to the first quarter, when operating revenue was $1.13 billion.

Tilden also noted that the company has paid much higher rates at Sea-Tac Airport this year than in the past, but that it recently reached an agreement in principle on a long-term lease with lower rates.

The company saw a 7.6 percent increase in capacity, but only a 3 percent increase in revenue. The cost of fuel also was up $8 million, or 2.2 percent on a 6.6 percent increase in consumption.

Overall, Chief Financial Officer Brandon Pedersen said the company expects another year-over-year decrease in revenues for the third quarter.

The company’s profits were enough to continue its capital spending, and pay down debt, as well as continue a stock repurchase.

The company’s 2013 operating cash flow was $590 million through the second quarter, compared to $455 million for the same period in 2012. Alaska Air spent $260 million in capital spending, taking delivery of four planes and making predelivery payments on several others.

Of the remaining free cash flow, $109 million was used to pay down debt.

According to the airline’s quarterly announcement, it raised its trailing 12-month return on invested capital, or ROIC, to 13 percent, compared to 12.3 percent for the 12 months that ended in June 2012.

That’s down slightly compared to the second quarter. The ROIC was 13.4 percent at the end of March.

Company representatives also talked about some in-state market changes during the July 25 investor call.

In response to a question, Harrison said the company’s recent decision to use turboprop planes for its Fairbanks to Anchorage runs would cut the cost about 30 percent.

Harrison said that lower airfares as well as operating costs, making it likely that consumers will see some of the benefit.

Harrison also noted that the company is working on the cargo capacity of those Q400s to meet the Anchorage-Fairbanks demand for both baggage and cargo.

Other sources of revenue highlighted in the call are the increasing bag and change fees the company announced in July.

Alaska Air officials also signaled that their growth rate will slow in the near term.

In the past few years, Alaska has significantly expanded its service, adding Hawaii flights out of several west coast destinations, and expanding its transcontinental offerings as well. Now, the growth will slow down, Tilden said.

In the second quarter of 2013 alone, the company announced 12 new Alaska Airlines flights, as well three new routes for Horizon and SkyWest.

Hawaii flights could go green by 2018.

The airline also announced July 24 that it was signing an agreement with Hawai’I BioEnergy to purchase biofuel.

The airline could use the biofuel for its Hawaii flights as early as 2018. The energy company, which is a consortium of venture capital companies and three major Hawaii landowners, is seeking regulatory approval for its plans. The company intends to make biofuels out of materials grown in Hawaii, most likely woody biomass.

Production will likely begin within five years of regulatory approval.

Alaska Airlines is the first airline to sign a contract with the energy company, and it’s second customer overall.

“We are pleased to be partnering with Hawai`i BioEnergy to encourage the production and commercial distribution of sustainable fuels,” wrote Keith Loveless, Alaska Air Group’s executive vice president and general counsel, in a statement announcing the agreement. “Beyond the environmental advantages, it improves the fuel supply integrity in the state of Hawaii, which will allow for the further growth of our airline operations throughout the Islands.”